Steven M. Bragg John Wiley and Sons, Inc.

Transcription

1 ESSENTIALS of Payroll: Management and Accounting Steven M. Bragg John Wiley and Sons, Inc.

2 Copyright 2003 by Steven M. Bragg. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, , fax , or on the web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, , fax , permcoordinator@wiley.com. Limit of Liability/Disclaimer of Warranty:While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at , outside the United States at , or fax Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at Library of Congress Cataloging-in-Publication Data Bragg, Steven M. Essentials of payroll : management and accounting / Steven M. Bragg. p. cm. -- (Essentials series) Includes index. ISBN (pbk.) 1.Wages--Accounting. 2. Payrolls--Management. 3.Wages--Accounting--Law and legislation--united States. I Title. II. Series. HG5681.W3 B '21--dc Printed in the United States of America

3 To Marge, who has put up with her preoccupied son-in-law for a very long time. Marge, you definitely break the mold of the traditional mother-in-law. You are practical, sensible, and a solid rock in the midst of life s uncertainties and don t even get me started about your vast treasure trove of cookies.

4

5 Acknowledgments Many thanks to John DeRemigis, who always calls to ask how I am doing, and then gets to the real point of the conversation: Have I thought of any great book ideas lately? vii

6

7 About the Author Steven Bragg, CPA, CMA, CIA, CPM, CPIM, has been the chief financial officer or controller of four companies, as well as a consulting manager at Ernst & Young, and an auditor at Deloitte & Touche. He received a master s degree in finance from Bentley College, an MBA from Babson College, and a bachelor s degree in Economics from the University of Maine. He has been the two-time president of the 10,000-member Colorado Mountain Club, and is an avid alpine skier, mountain biker, and rescue diver. Bragg resides in Centennial, Colorado. He has written the following books for John Wiley & Sons, Inc.: Accounting and Finance for Your Small Business, Accounting Best Practices, Accounting Reference Desktop, Business Ratios and Formulas, Controllership, Cost Accounting, Design and Maintenance of Accounting Manuals, Financial Analysis, Just-in-Time Accounting, Managing Explosive Corporate Growth, Outsourcing, Sales and Operations for Your Small Business, and The Controller s Function. In addition he is the author of Advanced Accounting Systems, published by The Institute of Internal Auditors in ix

8

9 Contents Preface xiii 1 Creating a Payroll System 1 2 Accumulating Time Worked 27 3 Payroll Procedures and Controls 49 4 Payroll Best Practices 73 5 Compensation Benefits Payroll Taxes and Remittances Payroll Deductions Payments to Employees Unemployment Insurance 241 Index 267 xi

10

11 Preface This book is designed for the accountant who is setting up a payroll system, wants to improve the efficiency of an existing system, or who needs answers to the inevitable variety of compensation, tax, deduction, and record-keeping issues associated with payroll. Each chapter includes an example of how a company has addressed a specific payroll issue, as well as Tips & Techniques that offer guidance on how to handle specific payroll situations. The book is divided into two parts.the first part addresses the overall set of policies and procedures, controls, and best practices that comprise a payroll system. The second part addresses the processing of specific transactions, encompassing compensation benefits, taxes, deductions, and other related issues. The chapters are as follows: Chapter 1: Creating a Payroll System. This chapter covers outsourced and in-house payroll systems, emphasizing both manual and computerized systems. Flowcharts are given for each type of system and for the control points used with each one. Chapter 2:Accumulating Time Worked. This chapter describes a variety of manual and automated methods for collecting time worked, and notes the situations in which each solution is most viable. Chapter 3: Payroll Procedures and Controls. This chapter contains detailed policies and procedures for the primary payroll functions, which can be easily adapted to suit one s individual circumstances. Chapter 4: Payroll Best Practices. This chapter describes a number of payroll best practices, which are highly efficient methods for operating xiii

12 Preface the payroll function. They are especially useful for any business that is striving to reduce its administrative costs in this area. Chapter 5: Compensation. This chapter covers such key topics as the status of contractors, wage exemption and payment guidelines, temporary workers, the minimum wage, compensation computations, tips, back pay, and a variety of business expense reimbursements. Chapter 6: Benefits. This chapter covers a number of payroll issues related to employee benefits, such as cafeteria plans, insurance, pension plans, sick pay, stock options, and workers compensation. Chapter 7: Payroll Taxes and Remittances. This chapter discusses the calculation of federal, Social Security, Medicare, and state income taxes, as well as taxation issues for resident aliens and citizens working abroad. It also covers the timing, reporting format, and related penalties for tax remittances. Chapter 8: Payroll Deductions. This chapter covers the calculation and related regulations for a number of payroll deductions related to asset purchases, charitable contributions, child support, pay advances, tax levies, and other items. Chapter 9: Payments to Employees. This chapter addresses the specific procedures for paying employees, using either cash, check, or direct deposit payments, as well as state regulations related to the frequency and timing of both regular and termination payments to employees. Chapter 10: Unemployment Insurance. This chapter addresses the structure of the federal unemployment tax system, as well as the calculation of unemployment taxes at the state level. It also covers the completion and proper depositing of related tax forms. For those new to the payroll function, this book is best read in sequential order from cover to cover. For those who are implementing a new payroll system, the first three chapters will be the most useful, while for those who want to improve their current systems, Chapters 3, xiv

13 Preface 4, and 9 are highly recommended. For those who are searching for answers to daily payroll-related questions about compensation or benefits, Chapters 5 through 8 are the most useful. In general, this book can also be used as a refresher class for those who have been involved in payroll issues for a long time, but who have not updated their skills recently. xv

14

15 CHAPTER 1 Creating a Payroll System After reading this chapter you will be able to Determine the differences in transaction steps between an outsourced, in-house computerized, and in-house manual payroll system Collect all the payroll and human resources information needed to assemble a new-employee hiring packet Properly assemble an employee s personnel folder and divide the information into easily accessible subsections Use a summary-level employee change form to centralize all employee change requests into a single document This chapter provides an overview of how the payroll process typically functions, using either a payroll supplier, an in-house payroll process assisted by computer systems, or an in-house system in which everything is processed entirely by hand. These descriptions include flowcharts of each process and details of the controls that are most useful for each situation. The chapter also covers the types of documents used to set up a new employee in the payroll system, how to organize this information into a personnel folder, and how to process changes to employee information through the payroll system. As noted in the summary, the information in this chapter is supplemented in later chapters with more detailed descriptions of specific payroll issues. 1

16 ESSENTIALS of Payroll: Management and Accounting Overview of the General Payroll Process The next three sections describe how the payroll process flows for specific types of systems: outsourced payroll, in-house computerized payroll, and in-house manual payroll. This section covers, step by step, the general beginning-to-end processing of payroll, irrespective of the specific payroll system, so that you can see the general process flow. Though some of these steps will not apply to all of the processes decribed later, this overview will give you a good feel for how a payroll is completed. Here are the steps: 1. Set up new employees. New employees must fill out payroll-specific information as part of the hiring process, such as the W-4 form and medical insurance forms that may require payroll deductions. Copies of this information should be set aside in the payroll department in anticipation of its inclusion in the next payroll. 2. Collect time card information. Salaried employees require no change in wages paid for each payroll, but an employer must collect and interpret information about hours worked for nonexempt employees. This may involve having employees scan a badge through a computerized time clock, punch a card in a stamp clock, or manually fill out a time sheet (see Chapter 2, Accumulating Time Worked ). 3. Verify time card information. Whatever the type of data collection system used in the previous step, the payroll staff must summarize this information and verify that employees have recorded the correct amount of time. This typically involves having supervisors review the information after it has been summarized, though more advanced computerized timekeeping systems can perform most of these tasks automatically. 2

17 Creating a Payroll System 4. Summarize wages due. This generally is a straightforward process of multiplying the number of hours worked by an employee s standard wage rate. That said, it can be complicated by overtime wages, shift differentials, bonuses, or the presence of a wage change partway through the reporting period (see Chapter 5, Compensation ). 5. Enter employee changes. Employees may ask to have changes made to their paychecks, typically in the form of alterations to the number of tax exemptions allowed, pension deductions, or medical deductions. Much of this information must be recorded for payroll processing purposes, since it may alter the amount of taxes or other types of deductions (see Chapter 8, Payroll Deductions ). T IPS &TECHNIQUES Compiling time cards, determining who earned overtime hours, and gathering supervisory approval of those hours is a common lastminute rush job prior to completing the payroll. One of the major payroll bottlenecks is locating supervisors, who have other things to do than approve overtime hours. One alternative is to skip the supervisory approval and instead report back to supervisors after the fact, so they can see the hours charged on a trend line of multiple pay periods. If there are employees who continually record an excessive amount of overtime, this information becomes abundantly clear in the report. Supervisors can then use this information to work with specific repeat offenders, possibly issuing a blanket order never to work overtime. A sample of this report is shown in Exhibit 1.1, which lists overtime hours worked for the past six months for a group of employees. Note that the hours of Mr. Grammatic clearly exceed those of the other employees, making him a target for supervisory action. Also, overtime hours tend to be similar for people working in the same area; notice in the report how everyone except Mr. Grammatic works roughly the same amount of overtime in the same periods. Clearly, there is a potential overtime problem highlighted by the report that requires further investigation. 3

18 ESSENTIALS of Payroll: Management and Accounting EXHIBIT 1.1 Overtime Trend Report Name Jan Feb Mar Apr May Jun Ashford, Mary Grammatic, John Lepsos, Harry Morway, Alice Zephyr, Horace Calculate applicable taxes. The payroll staff must either use IRSsupplied tax tables to manually calculate tax withholdings or have a computerized system or a supplier determine this information. Taxes will vary not only by wage levels and tax allowances taken, but also by the amount of wages that have already been earned for the year-to-date (see Chapter 7, Payroll Taxes and Remittances ). 7. Calculate applicable wage deductions. There are both voluntary and involuntary deductions. Voluntary deductions include payments into pension and medical plans; involuntary ones include garnishments and union dues. These can be made in regular amounts for each paycheck, once a month, in arrears, or prospectively. The payroll staff must also track goal amounts for some deductions, such as loans or garnishments, in order to know when to stop making deductions when required totals have been reached (see Chapter 8, Payroll Deductions ). 8. Account for separate manual payments. Inevitably there will be cases where the payroll staff has issued manual paychecks to employees between payrolls. This may have been done to rectify an incorrect 4

19 Creating a Payroll System prior paycheck; for an advance; or perhaps because of a termination. Whatever the reason, the amount of each manual check should be included in the regular payroll, at least so that it can be included in the formal payroll register for reporting purposes, and sometimes to ensure that the proper amount of employer-specific taxes are withheld to accompany the amounts deducted for the employee. 9. Create payroll register. Summarize the wage and deduction information for each employee on a payroll register; this can then be used to compile a journal entry for inclusion in the general ledger, to prepare tax reports, and for general research purposes. This document is always prepared automatically by payroll suppliers or by in-house computerized systems. 10. Verify wage and tax amounts. Conduct a final cross-check of all wage calculations and deductions. This can involve a comparison to the same amounts for prior periods or a general check for both missing information and numbers that are clearly out of line with expectations. 11. Print paychecks. Print paychecks, either manually on individual checks or, much more commonly, on a computer printer, using a standard format that itemizes all wage calculations and deductions on the remittance advice. Even when direct deposits are made, a remittance advice should be printed and issued. 12. Enter payroll information in the general ledger. Use the information in the payroll register to compile a journal entry that transfers the payroll expense, all deductions, and the reduction in cash to the general ledger. 13. Send out direct deposit notifications. If a company arranges with a local bank to issue payments directly to employee accounts, a 5

20 ESSENTIALS of Payroll: Management and Accounting notification of the accounts to which payments are to be sent and the amounts to be paid must be assembled, stored on tape or other media, and sent to the bank (see Chapter 9, Payments to Employees ). 14. Deposit withheld taxes. The employer must deposit all related payroll tax deductions and employer-matched taxes at a local bank that is authorized to handle these transactions. The IRS imposes a rigid deposit schedule and format for making deposits that must be followed in order to avoid penalties (see Chapter 7, Payroll Taxes and Remittances ). 15. Issue paychecks. Paychecks should, at least occasionally, be handed out directly to employees, with proof of identification required; this is a useful control point in larger companies where the payroll T IPS &TECHNIQUES The control point for periodically handing out paychecks only to those who can prove their identity is not entirely useful when many employees use direct deposit, and therefore do not care if they receive an accompanying remittance advice or not. This is an especially galling problem for companies that may have many locations or that have employees who travel constantly. In both of these cases, a physical identity check is not a viable control. An alternative control is to periodically issue lists of paycheck recipients to department managers so they can see if any names on the lists are not those of current employees. But this is a weaker control, because the department managers may not take the time to verify this information. A backup control is to compare paycheck information to other information that is independently maintained for current employees, such as free life insurance that all employees sign up for when hired. A false employee name in the payroll register will not appear on a corresponding list of benefits, indicating a potential control problem. 6

21 Creating a Payroll System staff may not know each employee by name and where there is, therefore, some risk of paychecks being created for people who no longer work for the company (see Chapter 9, Payments to Employees ). 16. Issue government payroll reports. The government requires several payroll-related reports at regular intervals, which require information on the payroll register to complete. Overview of the Outsourced Payroll Process Outsourcing the payroll processing function shifts a number of key payroll processing tasks to a supplier, resulting in a significant drop in the payroll department s workload, its required level of expertise in operating computer software, and in the risk that payroll taxes will not be remitted to the government in a timely manner. For these and other reasons, outsourcing payroll is an extremely popular option, especially for smaller businesses that do not have much in-house payroll expertise on hand. The basic process flow for an outsourced payroll function is shown in Exhibit 1.2. Note that the key items in the exhibit are the tasks that are not shown because they have been taken over by the payroll supplier. These tasks include processing the payroll transactions, printing payroll reports and paychecks, and making tax deposits and reports to the government on behalf of the company. By outsourcing these activities, the payroll staff is required only to compile and verify incoming data about hours worked, load it into the supplier s payroll system, and verify that the results are accurate. The process tasks noted in the exhibit can be streamlined by taking several additional steps. First, use a computerized timekeeping system that will prevent unauthorized overtime and automatically issue reports 7

22 ESSENTIALS of Payroll: Management and Accounting EXHIBIT 1.2 The Outsourced Payroll Process Notify employees about missing hours. File change forms in employee folders. File time cards separately. Review hours from timekeeping system. Enter hours and payroll changes into supplier s system. Verify totals with supplier or online. Receive paychecks and reports from supplier. OK? Yes Create and post journal entries for payroll transactions. File payroll reports. No Obtain supervisory approval of overtime hours worked. Distribute paychecks. Collect manual paycheck information. Collect employee change forms. that highlight hours that were not logged in by employees, thereby eliminating two steps from the data collection part of the process. Second, some payroll suppliers sell computerized timekeeping systems that link directly into their systems, so there is no need to manually load this information into the supplier s system (or call it in to a data entry person). Third, a company can pay the supplier to create customized summary-level reports that can be used as the foundation for journal entries, which eliminates additional work. Finally, some suppliers now issue payroll reports on compact disc (CD), which nearly eliminates the filing chore. By taking advantage of these additional outsourcing features, the payroll process can become a very efficient system. Controls over the outsourced payroll process are fewer than required for other systems, because there is no need to control the check stock 8

23 CHAPTER 1 Creating a Payroll System After reading this chapter you will be able to Determine the differences in transaction steps between an outsourced, in-house computerized, and in-house manual payroll system Collect all the payroll and human resources information needed to assemble a new-employee hiring packet Properly assemble an employee s personnel folder and divide the information into easily accessible subsections Use a summary-level employee change form to centralize all employee change requests into a single document This chapter provides an overview of how the payroll process typically functions, using either a payroll supplier, an in-house payroll process assisted by computer systems, or an in-house system in which everything is processed entirely by hand. These descriptions include flowcharts of each process and details of the controls that are most useful for each situation. The chapter also covers the types of documents used to set up a new employee in the payroll system, how to organize this information into a personnel folder, and how to process changes to employee information through the payroll system. As noted in the summary, the information in this chapter is supplemented in later chapters with more detailed descriptions of specific payroll issues. 1

24 ESSENTIALS of Payroll: Management and Accounting Overview of the General Payroll Process The next three sections describe how the payroll process flows for specific types of systems: outsourced payroll, in-house computerized payroll, and in-house manual payroll. This section covers, step by step, the general beginning-to-end processing of payroll, irrespective of the specific payroll system, so that you can see the general process flow. Though some of these steps will not apply to all of the processes decribed later, this overview will give you a good feel for how a payroll is completed. Here are the steps: 1. Set up new employees. New employees must fill out payroll-specific information as part of the hiring process, such as the W-4 form and medical insurance forms that may require payroll deductions. Copies of this information should be set aside in the payroll department in anticipation of its inclusion in the next payroll. 2. Collect time card information. Salaried employees require no change in wages paid for each payroll, but an employer must collect and interpret information about hours worked for nonexempt employees. This may involve having employees scan a badge through a computerized time clock, punch a card in a stamp clock, or manually fill out a time sheet (see Chapter 2, Accumulating Time Worked ). 3. Verify time card information. Whatever the type of data collection system used in the previous step, the payroll staff must summarize this information and verify that employees have recorded the correct amount of time. This typically involves having supervisors review the information after it has been summarized, though more advanced computerized timekeeping systems can perform most of these tasks automatically. 2

25 Creating a Payroll System 4. Summarize wages due. This generally is a straightforward process of multiplying the number of hours worked by an employee s standard wage rate. That said, it can be complicated by overtime wages, shift differentials, bonuses, or the presence of a wage change partway through the reporting period (see Chapter 5, Compensation ). 5. Enter employee changes. Employees may ask to have changes made to their paychecks, typically in the form of alterations to the number of tax exemptions allowed, pension deductions, or medical deductions. Much of this information must be recorded for payroll processing purposes, since it may alter the amount of taxes or other types of deductions (see Chapter 8, Payroll Deductions ). T IPS &TECHNIQUES Compiling time cards, determining who earned overtime hours, and gathering supervisory approval of those hours is a common lastminute rush job prior to completing the payroll. One of the major payroll bottlenecks is locating supervisors, who have other things to do than approve overtime hours. One alternative is to skip the supervisory approval and instead report back to supervisors after the fact, so they can see the hours charged on a trend line of multiple pay periods. If there are employees who continually record an excessive amount of overtime, this information becomes abundantly clear in the report. Supervisors can then use this information to work with specific repeat offenders, possibly issuing a blanket order never to work overtime. A sample of this report is shown in Exhibit 1.1, which lists overtime hours worked for the past six months for a group of employees. Note that the hours of Mr. Grammatic clearly exceed those of the other employees, making him a target for supervisory action. Also, overtime hours tend to be similar for people working in the same area; notice in the report how everyone except Mr. Grammatic works roughly the same amount of overtime in the same periods. Clearly, there is a potential overtime problem highlighted by the report that requires further investigation. 3

26 ESSENTIALS of Payroll: Management and Accounting EXHIBIT 1.1 Overtime Trend Report Name Jan Feb Mar Apr May Jun Ashford, Mary Grammatic, John Lepsos, Harry Morway, Alice Zephyr, Horace Calculate applicable taxes. The payroll staff must either use IRSsupplied tax tables to manually calculate tax withholdings or have a computerized system or a supplier determine this information. Taxes will vary not only by wage levels and tax allowances taken, but also by the amount of wages that have already been earned for the year-to-date (see Chapter 7, Payroll Taxes and Remittances ). 7. Calculate applicable wage deductions. There are both voluntary and involuntary deductions. Voluntary deductions include payments into pension and medical plans; involuntary ones include garnishments and union dues. These can be made in regular amounts for each paycheck, once a month, in arrears, or prospectively. The payroll staff must also track goal amounts for some deductions, such as loans or garnishments, in order to know when to stop making deductions when required totals have been reached (see Chapter 8, Payroll Deductions ). 8. Account for separate manual payments. Inevitably there will be cases where the payroll staff has issued manual paychecks to employees between payrolls. This may have been done to rectify an incorrect 4

27 Creating a Payroll System prior paycheck; for an advance; or perhaps because of a termination. Whatever the reason, the amount of each manual check should be included in the regular payroll, at least so that it can be included in the formal payroll register for reporting purposes, and sometimes to ensure that the proper amount of employer-specific taxes are withheld to accompany the amounts deducted for the employee. 9. Create payroll register. Summarize the wage and deduction information for each employee on a payroll register; this can then be used to compile a journal entry for inclusion in the general ledger, to prepare tax reports, and for general research purposes. This document is always prepared automatically by payroll suppliers or by in-house computerized systems. 10. Verify wage and tax amounts. Conduct a final cross-check of all wage calculations and deductions. This can involve a comparison to the same amounts for prior periods or a general check for both missing information and numbers that are clearly out of line with expectations. 11. Print paychecks. Print paychecks, either manually on individual checks or, much more commonly, on a computer printer, using a standard format that itemizes all wage calculations and deductions on the remittance advice. Even when direct deposits are made, a remittance advice should be printed and issued. 12. Enter payroll information in the general ledger. Use the information in the payroll register to compile a journal entry that transfers the payroll expense, all deductions, and the reduction in cash to the general ledger. 13. Send out direct deposit notifications. If a company arranges with a local bank to issue payments directly to employee accounts, a 5

28 ESSENTIALS of Payroll: Management and Accounting notification of the accounts to which payments are to be sent and the amounts to be paid must be assembled, stored on tape or other media, and sent to the bank (see Chapter 9, Payments to Employees ). 14. Deposit withheld taxes. The employer must deposit all related payroll tax deductions and employer-matched taxes at a local bank that is authorized to handle these transactions. The IRS imposes a rigid deposit schedule and format for making deposits that must be followed in order to avoid penalties (see Chapter 7, Payroll Taxes and Remittances ). 15. Issue paychecks. Paychecks should, at least occasionally, be handed out directly to employees, with proof of identification required; this is a useful control point in larger companies where the payroll T IPS &TECHNIQUES The control point for periodically handing out paychecks only to those who can prove their identity is not entirely useful when many employees use direct deposit, and therefore do not care if they receive an accompanying remittance advice or not. This is an especially galling problem for companies that may have many locations or that have employees who travel constantly. In both of these cases, a physical identity check is not a viable control. An alternative control is to periodically issue lists of paycheck recipients to department managers so they can see if any names on the lists are not those of current employees. But this is a weaker control, because the department managers may not take the time to verify this information. A backup control is to compare paycheck information to other information that is independently maintained for current employees, such as free life insurance that all employees sign up for when hired. A false employee name in the payroll register will not appear on a corresponding list of benefits, indicating a potential control problem. 6

29 Creating a Payroll System staff may not know each employee by name and where there is, therefore, some risk of paychecks being created for people who no longer work for the company (see Chapter 9, Payments to Employees ). 16. Issue government payroll reports. The government requires several payroll-related reports at regular intervals, which require information on the payroll register to complete. Overview of the Outsourced Payroll Process Outsourcing the payroll processing function shifts a number of key payroll processing tasks to a supplier, resulting in a significant drop in the payroll department s workload, its required level of expertise in operating computer software, and in the risk that payroll taxes will not be remitted to the government in a timely manner. For these and other reasons, outsourcing payroll is an extremely popular option, especially for smaller businesses that do not have much in-house payroll expertise on hand. The basic process flow for an outsourced payroll function is shown in Exhibit 1.2. Note that the key items in the exhibit are the tasks that are not shown because they have been taken over by the payroll supplier. These tasks include processing the payroll transactions, printing payroll reports and paychecks, and making tax deposits and reports to the government on behalf of the company. By outsourcing these activities, the payroll staff is required only to compile and verify incoming data about hours worked, load it into the supplier s payroll system, and verify that the results are accurate. The process tasks noted in the exhibit can be streamlined by taking several additional steps. First, use a computerized timekeeping system that will prevent unauthorized overtime and automatically issue reports 7

30 ESSENTIALS of Payroll: Management and Accounting EXHIBIT 1.2 The Outsourced Payroll Process Notify employees about missing hours. File change forms in employee folders. File time cards separately. Review hours from timekeeping system. Enter hours and payroll changes into supplier s system. Verify totals with supplier or online. Receive paychecks and reports from supplier. OK? Yes Create and post journal entries for payroll transactions. File payroll reports. No Obtain supervisory approval of overtime hours worked. Distribute paychecks. Collect manual paycheck information. Collect employee change forms. that highlight hours that were not logged in by employees, thereby eliminating two steps from the data collection part of the process. Second, some payroll suppliers sell computerized timekeeping systems that link directly into their systems, so there is no need to manually load this information into the supplier s system (or call it in to a data entry person). Third, a company can pay the supplier to create customized summary-level reports that can be used as the foundation for journal entries, which eliminates additional work. Finally, some suppliers now issue payroll reports on compact disc (CD), which nearly eliminates the filing chore. By taking advantage of these additional outsourcing features, the payroll process can become a very efficient system. Controls over the outsourced payroll process are fewer than required for other systems, because there is no need to control the check stock 8

31 Creating a Payroll System or signature plates, which are handled by the supplier. Consequently, the primary controls tend to be at the beginning and end of the process. As shown in the boxes with bold lettering in Exhibit 1.3, there should be an approval process for overtime hours worked, as well as for negative deductions. A negative deduction is essentially a payment to an employee; if used repeatedly, even incrementally small amounts could add up to a significant pay increase for an employee. For larger companies with many employees, you should also compare the addresses on the employee paychecks to see if a fake employee has been added to the system, with the check being mailed to a current employee s address to be cashed by that person. You can also issue a list of the names of people receiving EXHIBIT 1.3 Controls for the Outsourced Payroll Process Review hours from timekeeping system. Enter hours and payroll changes into supplier s system. Verify totals with supplier or online. Receive paychecks and reports from supplier. OK? Yes Compare addresses on employee paychecks. Issue paychecks list to department supervisors. No Obtain approval of overtime hours worked. Issue checks directly to recipients. Obtain approval of pay changes. Collect employee change forms. Obtain approval of negative deductions. 9

32 ESSENTIALS of Payroll: Management and Accounting paychecks to the department supervisors to see if any fake names or the names of departed employees crop up. Finally, you can also spot fake employees by handing out checks directly to employees after they show some form of identification. Not all of these controls are necessary, but you should select those that make the most sense for a company s specific circumstances. Overview of the In-House Computerized Payroll Process A payroll system that is just as popular as outsourcing is the in-house computerized system. Payroll software is very inexpensive, as it is now bundled with accounting software that costs just a few hundred dollars. More comprehensive systems, for use with large numbers of employees, are much more expensive, but are a cost-effective solution for large entities. The basic process flow for an in-house computerized payroll process is shown in Exhibit 1.4. A fully automated process involves the review and verification of hours worked and other changes as entered by the employees, followed by the processing and printing of payroll reports, filing of direct deposit information and payroll taxes, and the distribution of paychecks. The flowchart assumes a complete automation of all key payroll functions. For example, a computerized timekeeping system is assumed. This system, as described in Chapter 2, requires employees to run a badge through a time clock that can reject the scan if the employee is clocking in at the wrong time or is attempting to work during an unauthorized overtime period. By using such a system, the payroll process is considerably reduced at the front end, with the payroll staff only having to investigate missing badge scans. The process flow also assumes that employees can make their own deduction and address changes through an interface to the payroll software, so that the payroll staff only has to 10

33 Creating a Payroll System EXHIBIT 1.4 The In-House Computerized Payroll Process Back up computer files. Investigate missing time card scans. Transfer timekeeping file to payroll system. Process payroll on in-house software. Print and review preliminary payroll reports. OK? Yes File payroll reports. Send direct deposit instructions to bank. No Review employeeentered changes. Deposit withheld and matching federal taxes at bank. Deposit withheld state income and other taxes. Related Activities File quarterly federal tax return. File annual federal unemployment tax return. Issue annual W-2 forms to employees and government. Distribute paychecks. review these changes. Further, the process flow assumes that the timekeeping database used by the time clock computer feeds directly into the in-house payroll software, which eliminates the keypunching of payroll data. If any of these automation elements are not present, then the process flowchart appears as a mix between in-house computerization and a manual system, which is shown later in Exhibit 1.6. There are several key differences between the automated in-house system shown in Exhibit 1.4 and the outsourced solution in Exhibit 1.2. A key difference is that an in-house system requires the payroll department to file several tax returns, which would otherwise have to be filed by the payroll supplier. These include the quarterly federal tax return, the annual federal unemployment tax return, and annual W-2 forms to employees. 11

34 ESSENTIALS of Payroll: Management and Accounting There may also be a variety of state reports to file. Further, an in-house system that uses direct deposit requires the payroll staff to create a database of direct deposit information and send it to the company s bank, which uses it to process direct deposits to employees; otherwise, this would have to be handled by a payroll supplier. Third, the in-house payroll database must be backed up and stored, which is normally handled by the payroll supplier. Finally, an in-house system requires the payroll staff to summarize all tax deposits, fill out remittance forms, and file payments with the federal and state governments at regular intervals. Consequently, no matter how much control a company may feel it has by using an in-house computerized system, the payroll staff will have a number of additional tasks to perform. Controls for the in-house computerized payroll process are noted in the boxes with bold lettering in Exhibit 1.5. Due to the assumed use of a computerized timekeeping system, in the exhibit no controls are required for timekeeping activities, since the computer can spot them. (If a company does not have such a system, then review either the outsourced or manual control systems in Exhibits 1.3 or 1.7 for the controls covering this area.) In addition to those controls shown earlier for the outsourced system, new controls are also needed for check stock and signature plates, both of which should be securely locked up at all times. Be sure to note at the very end of the process flowchart the controls for reviewing uncashed checks and performing bank reconciliations. These controls are designed to spot payments made to employees who are no longer with the company and who, therefore, never received the checks (which were probably issued in error). These two controls can be added to the earlier outsourced payroll system, though some suppliers will notify a company of any uncashed checks, depending on the outsourcing arrangement. 12

35 Creating a Payroll System EXHIBIT 1.5 Controls for the In-House Computerized Payroll Process Obtain approval of pay changes. Control check stock. Investigate missing time card scans. Transfer timekeeping file to payroll system. Process payroll on in-house software. Print and review preliminary payroll reports. OK? Create paychecks. Compare addresses on employee paychecks. No Obtain approval of negative deductions. Control signature plates. Issue paychecks list to department supervisors. Send direct deposit instructions to bank. Perform bank reconciliations. Review uncashed checks. Issue checks directly to recipients. Deposit withheld and matching taxes at bank. Overview of the In-House Manual Payroll Process An increasingly rarely used payroll system is the completely manual approach that precludes all use of payroll suppliers or in-house computer systems. This type of system is most commonly found in very small organizations where the additional labor required to calculate wages and taxes is not too onerous for the small accounting staff. The manual process requires extra labor in three key areas. First, employees are filling out time cards by hand or using a punch clock, so the payroll staff must use a calculator to add up the hours worked, verify the calculations (since this task is highly subject to errors), notify employees about missing time entries, and have supervisors approve any overtime hours worked. Second, the payroll staff must multiply hours worked by hourly pay rates to determine wages for the nonexempt 13

36 ESSENTIALS of Payroll: Management and Accounting employees, and then use IRS-provided tax tables to determine the amount of taxes to withhold, plus the amount of matching taxes to be remitted by the company. This task is also subject to a high error rate and should be reviewed with care. Third, the payroll staff must create paychecks from the prior information and manually summarize the results in a payroll register. And because employees expect to see all deductions broken out on their paychecks, the paycheck-writing process is lengthy. In comparison to the outsourcing and in-house computer system solutions described previously, the manual payroll process is painfully slow and is at risk of so many errors that the payroll staff will find itself taking a disproportionate amount of its time to ensure that outputs from the process are correct. The manual payroll process is shown in the flowchart in Exhibit 1.6. EXHIBIT 1.6 The In-House Manual Payroll Process Notify employees about missing hours. No Compile time card totals. Manually calculate wages due. Manually calculate taxes due. Manually generate payroll register. OK? Yes Create paychecks. Create and post journal entries for payroll transactions. Obtain supervisory approval of overtime worked. File payroll register. Collect manual paycheck information. Collect employee change forms. Deposit withheld and matching federal taxes at bank. Related Activities File quarterly federal tax return. File annual federal unemployment tax return. Issue annual W-2 forms to employees and government. Distribute paychecks. Deposit withheld state income and other taxes. 14

37 Creating a Payroll System The flowchart does not mention the preparation of a direct deposit database that can be forwarded to a bank, since it is most unlikely that a company without means to calculate its payroll on a computer will be able to create the direct deposit database.also, the three types of reports shown in the lower left corner of Exhibit 1.6 will require manual completion, which would not necessarily be the case if an in-house computerized system were used, as such systems often have the capability to produce these standard tax reports at the touch of a button. The controls for an in-house manual payroll process are shown in Exhibit 1.7. Since there is an assumption that no automated timekeeping system is in place, two key controls are to verify total hours worked and to obtain supervisory approval of overtime hours worked. Other controls later in the process are similar to those found in the computerized EXHIBIT 1.7 Controls for In-House Manual Payroll Process Verify hours worked. Control check stock. No Compile time card totals. Manually calculate wages due. Manually calculate taxes due. Manually generate payroll register. OK? Yes Create paychecks. Create and post journal entries for payroll transactions. Obtain approval of overtime hours worked. Fill in empty spaces on checks. Deposit withheld and matching federal taxes at bank. Collect manual paycheck information. Collect employee change forms. Deposit withheld state income and other taxes. Obtain approval of pay changes and negative deductions. Perform bank reconciliations. Review uncashed checks. Issue checks directly to recipients. 15

38 ESSENTIALS of Payroll: Management and Accounting in-house system, since some monitoring of check stock and signature plates must be maintained. However, some of the reviews for fake employees at the end of the process, such as comparing addresses on checks, can probably be discarded, since this type of process is typically used for companies so small that the payroll staff knows everyone who works for the company. Setting Up the New Employee When a new employee is hired, the human resources staff will go over a variety of paperwork with the person, and forward to the payroll department any items required by the payroll staff to calculate the person s wages, taxes, and other deductions. However, in a smaller firm with no human resources staff, it is common for the payroll department to perform this function, in which case the payroll staff should be aware of the variety of forms that are typically included in the new employee packet. Though some forms may be specific to an individual business, the following forms will be found in most cases: Check-off sheet. At the front of each new employee packet should be a check-off list that itemizes all documents contained in the packet. By using it to verify that a package is complete, there is minimal risk that new employees will not be issued critical information. It is also useful to include the latest form release date on this sheet, to verify the document dates contained in the packet. Company go-to list. A new employee has no idea whom to approach regarding basic daily issues, such as phone and network problems, pension plan enrollments, expense reports, and so on. This list should itemize which people he or she should approach about each type of problem; it s also a good idea to include a backup person for each item. Company phone list. For a smaller company, this list should itemize not only the work number for each employee, but also 16

39 Creating a Payroll System the cell phone or other number at which they can most easily be reached. It is also increasingly customary to include addresses on this list. For larger companies with lengthy phone lists, the phone list for the department to which an employee belongs may be sufficient. Company seating chart. For a smaller company, it is quite useful to issue a seating chart that lists every person in the company. As with phone lists, a larger company may have to provide a chart showing smaller subsets of the company. This chart will require a reasonable amount of maintenance, given the number of moves typically experienced in large companies. Insurance enrollment forms. Enrollment forms for a variety of insurance types can be issued to a new employee at a later date if there is a waiting period before they go into effect. That said, it is possible for some employees to fall between the cracks and never be issued the forms; consequently, a better approach is to issue these forms at the same time that an employee receives all other paperwork, so there is no chance of their being missed. Enrollment forms can cover medical, vision, dental, life, supplemental life, and short- and long-term disability insurance. Some insurance carriers provide a wide range of coverages in a single application, but this is the exception, so be prepared to issue a large number of documents. Veterans check-off form. Companies are required to submit the VETS-100 form to the federal government once a year, which specifies the proportion of military veterans in the corporate workforce. It is easiest to track this information by having new employees fill out a simple check-off form that itemizes whether they have been engaged in military service in the past. Employee manual. There should be a comprehensive employee manual in the new-employee packet that includes a tear-out acknowledgment of receipt. The employee signs this receipt to indicate that he or she has received and read it; the receipt 17